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«Compacts of Free Association with the Federated States of Micronesia (FSM) and the Republic of the Marshall Islands (RMI) For Fiscal Year 2006 Table ...»

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Production of copra, the dried white flesh of a coconut, continues. However, its relative share as a part of the local production economy will continue to decline as other activities present more attractive options, especially to those with education and skills.

Tourism holds potential, particularly in specialty areas such as diving, sports fishing and other forms of recreational activities, such as boating, that take advantage of the Pacific Ocean. There may be cruise ship possibilities in the future. Business and government travelers provide another market. The Compact provides that, for purposes of Internal Revenue Code section 274(h)(3)(A), the RMI is included in the “North American Area” for purposes of the allowance of deductions for foreign conventions. Deductions for foreign conventions, meetings, or seminars are otherwise generally disallowed under the Internal Revenue Code, unlike events occurring in jurisdictions included in the “North American Area.” Tourist traffic data compiled by the Marshall Islands Visitors Authority (MIVA) illustrate the potential of tourism as a future income source, notwithstanding its smallness today.

In 1991, 5,872 visitors arrived in Majuro, the RMI’s capital and the only atoll connected directly to the outside world by regular commercial air service. A decade later, the total was slightly lower, perhaps because of the impact of terrorist attacks on the United States which dampened tourist traffic throughout the Western Pacific. Arrivals increased moderately in 2002 to 6,002 and a bit more in 2003 to 7,195. In 2004, the total reached 9,007, 25.2 percent higher than in 2003 and 53.4 percent higher than in 1991. In 2005, the total was up yet again to 9,173, a sign signaling a certain degree of consistency of increase, especially during the 2001-2005 period.

The more remarkable aspect of the increase in tourist traffic has been the gain in vacation travelers.. In 2001-2005, all visitors increased 68.5 percent from 5,444 to 9,173. During the same period, vacation travelers increased 83.9 percent, from 1,483 to 2,727. In the context of tourist traffic data, a few years hardly constitute a trend, but the relatively steady increase of vacation travelers in 2001-2005 suggests that there is room for growth.

That Majuro has a number of regionally competitive hotel rooms and other visitor facilities such as restaurants should make it easier to sell the destination.

In late 2006, the RMI government announced that it had reached an agreement with Japan Airlines (JAL) for charter flights from Tokyo to Majuro, starting in early 2007.

JAL flights to Majuro would be seen as a major milestone in the evolution of the RMI’s tourism industry. The flights will be seen both as an economic and symbolic achievement for the RMI. Economically, Japanese tourists are among the most desirable in the region because they tend to spend more money per person than most other tourists in places they visit. Even if Japanese tourist numbers are small initially, their spending would certainly make a difference in the local market which is also small. Symbolically, flights by JAL to Majuro would put the RMI on the region’s travel and leisure map. It is possible that Japanese traveling to the RMI would have specialized interests in, say, diving, exploring World War II ship wrecks and other such activities. Still, any number of travelers from an important regional market to the RMI would be a signal of a more promising future in regional tourism. It would benefit one of the region’s destinations that needs to be discovered by more travelers.

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6,000 5,000 4,000 3,000 2,000 1,000 Another important project announced by the RMI government in late 2006 was to take advantage of the country’s other major natural resource, fish. In fact, this will be the RMI’s second attempt to extract greater economic value from the fish in its waters. With the closing down of the RMI’s first fish processing (loining) plant in 2004 that employed as many as 300 workers and struggled to stay open during its short life, questions arose whether there was a way to exploit the country’s most abundant ocean resource. In fact, the closing of the facility raised questions about the RMI’s ability to put to commercial use a resource its people have used as a food source throughout history. The announcement said that a new, larger processing facility would be set up which would employ as many as 500-600 workers. It would commence work in early 2007. With about twice the number of workers as the first one, the new fish processing plant would also require a much larger initial investment, estimated to be around $60 million.

Few details have been available since the announcement was made in November, but it was, just as the arrangement with JAL, an important future project that would have both economic and symbolic value to the RMI. The economic value of what will be the largest private-sector employer in the RMI will be quite significant. A plant that would employ 600 workers will create supply-chain reaction that, in the end, will be much more than either the payroll or total sales of the plant alone. It would involve local buying power for those who work directly at the plant and that created by suppliers and other service providers connected to the facility. The final total effect on the RMI economy would be much greater than the compensation of 600 workers.

These two initiatives show that the RMI government is making a concerted effort to find income sources that would complement Compact funding and U.S. military outlays. If these ventures succeed, they will be seen as a concrete contribution to the efforts towards building that more self-reliant post-Compact economy.

Apart from the production and distribution possibilities within the indigenous economic base are the RMI’s most valuable physical assets, its location and strategic ties to the United States. The RMI’s contribution to United States strategic assets and facilities is a valuable comparative economic advantage that has been successfully translated into a reliable income stream. The amended Compact offers an additional significant advantage to RMI citizens, the right to travel to and reside and work in the United States. Also, more islanders living in the United States at some stage can become a valuable source of income as they may send money home to relatives.

Migration to the United States and its territories will continue in the years ahead, even if local economic conditions improve. Among the peculiarities of island economies, in the Pacific as elsewhere, is, that they cannot benefit from trade in goods as large economies can. Instead, they engage in trade in labor, but it usually takes place in one direction, from the islands, especially to developed economies where there are more work and study opportunities. The phenomenon often labeled “brain drain,” the flight of motivated and skilled labor to advanced economies, is a natural extension of the principle of trade that happens to involve people.

As a growth and development tool, trade in goods works better for large economies, such as Mexico and, more recently, China. Even with rudimentary production skills, Chinese workers have increasingly engaged in the production of a wide variety of goods for export to rich countries, especially the United States. Manufacturers of basic goods have moved their operations from rich countries to China, for instance, mainly because of low cost of labor. Meanwhile, the foreign exchange the exports bring to China is a major source of income and domestic savings, so much so that some of it ends up funding international debt, including that of the United States. As Chinese workers improve their production and distribution skills, they gradually move from basic manufacturing to more advanced work, with increasingly larger knowledge content that generates greater value added. As these skills become more advanced and more widespread through industries and regions in China, for example, they lift the whole economy. India is now becoming a major supplier and exporter of high tech and high knowledge content goods and services and just, as in the case of China, this particular export and the foreign exchange India earns from it lifts the whole economy.

By contrast, small economies of the Pacific with small landmasses and populations cannot benefit from trade in goods as large economies can. The constraints citizens of small economies have to work with force some of them, especially those with skill and the potential to make a living elsewhere, to engage in trade in labor (migration). The luxury the RMI (and FSM) has is that its people can travel to and reside and work in the world’s most dynamic labor market, the United States. However, not all of those who want to work, with basic or advanced skills, would leave the islands. And those who stay need to have an economy that will support them. Once again, the only answer to this ongoing quandary is to start building that post-Compact economy of the future now.

With more stringent financial resource allocation controls guiding the amended Compact, the RMI’s financial situation has the potential to improve and the RMI government has made financial stability a main objective. The JEMFAC, on which the United States has the majority vote, can play an instrumental role in both allocating and managing United States assistance in a manner that reduces misallocation. With financial controls in place, it is expected that increased benefit from Compact funds will accrue to the people of the Marshall Islands over the next 17 years.

(B) Use and Effectiveness of United States Financial, Program and Technical Assistance Funds The FSM and the RMI receive significant financial, program, and technical assistance support from the United States Government. The amended Compacts provide the largest proportion of assistance through sector grants, trust fund transfers and other support, but the two governments also receive annual program support from a variety of Federal agencies. In addition to administering Compact funds, the United States Department of the Interior continues to provide discretionary grants for technical assistance, operations and maintenance of public infrastructure, and to protect coral reefs.

The Office of Insular Affairs has had difficulty with measuring the overall effectiveness of financial assistance to the FSM and the RMI. This difficulty stems from the absence of current and complete data from the FSM and RMI governments, which impedes our ability to monitor economic and financial performance on a recurrent basis. In the FSM, for the third consecutive year, correlations between budgets, national strategic outcomes, and sector goals are unclear. Most FSM budgets also lack quantifiable annual performance targets.

Compact Sector and Supplemental Education Grants

In fiscal year 2006, the United States Department of the Interior managed in excess of $148,727,048 in Compact sector grant funds. Of that total, the RMI received an inflation-adjusted amount of $35,143,528. The FSM’s inflation-adjusted portion of $113,583,520 included six new grants and fiscal year 2004 and fiscal year 2005 infrastructure grant funds that were de-obligated and re-awarded in fiscal year 2006. Not detailed here are the FSM’s and the RMI’s fiscal year 2004 and 2005 carryover sector grant allocations. These amounts remain available until expended by the countries and restricted to purposes for which the grants were originally awarded.

As mandated by the amended Compacts, funding for both countries continued to target a limited array of government sectors and, within those sectors, only specific aims to achieve enhanced accountability, safeguard the effective use of funds, and strengthen the

foundation needed for economic stability and future growth:

Education: Education sector grants are to support and improve the educational systems of the governments and develop the human and material resources necessary for the two governments to perform these services. The amended Compacts require that funding allocations emphasize: (1) the advancement of a quality basic education system by increasing primary and secondary student achievement as measured by performance standards and assessments appropriate to the two countries; (2) the provision of secondary education or vocational training to qualified students; (3) the improvement of management and accountability within the educational systems; and (4) raising the level of staff quality and improving the relevance of education to the needs of the economy.

Health: Health sector grants are to support and improve the delivery of preventive, curative, and environmental health care, and develop the human and material resources necessary for the two governments to provide health services.

The sector’s priority is the establishment of sustainable funding mechanisms for operating community-based systems with emphasis on prevention, primary care, mental health and substance abuse prevention, and the operation of hospitals and dispensaries (clinics) to provide secondary care at appropriate levels and reduce reliance on medical referrals abroad.

Public Infrastructure: The highest priority funding uses for grants in this area are for primary and secondary education capital projects and projects that directly affect health and safety, including water and wastewater projects, solid waste disposal projects, and health care facilities. Secondary priorities are projects related to economic growth and development. Examples include airport and seaport improvements, roads, sea walls, and energy development that cannot be funded through existing rate structures.

Private-Sector Development: Private-sector development grants support the efforts of the two governments to attract new foreign investment and increase indigenous business activity by revitalizing the commercial environment;

ensuring fair and equitable application of the law, promoting adherence to core labor standards, and maintaining progress toward the privatization of state-owned and partially state-owned enterprises, and, engaging in other reforms. Grant priorities include advancing the private development of fisheries, tourism, and agriculture; employing new telecommunication technologies, and, analyzing and developing new systems, laws, regulations, and policies that foster private sector development, and to develop business and entrepreneurial skills.

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